High Expectations

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In 2014, Brazil entered the World Cup expecting to win. Brazil’s five World Cup trophies were expected to become six. They were also hosting. 

Vegas placed their odds to win it all at 3-1, a 25% implied probability. The only question, in most Brazilian minds, was who they'd beat in the final.

Then Neymar's back broke against Colombia. Thiago Silva picked up a yellow card and was suspended. Two key players gone before the semifinal. Germany was waiting.

What happened next didn't feel like a football match. Germany scored five goals in eighteen minutes. Fans wept in the stands while the game was still being played. The final score was 7-1. 

High expectations ended in disappointment. 

The 1999 St. Louis Rams were 4-12 the previous season. Vegas set their preseason Super Bowl odds at +15000 (150-to-1). This would make them the biggest preseason longshot to ever win the Super Bowl since odds tracking began in 1977. 

Their starting quarterback Trent Green tore his knee in the preseason. His replacement, Kurt Warner had been stocking shelves in a grocery store a few years earlier, then bounced through the Arena League. By every reasonable measure, this was a team with no business being good, let alone great. 

They won the Super Bowl. Kurt Warner was named NFL MVP and Super Bowl MVP. Running back Marshall Faulk also had the best year of his career. 

No one saw them coming. Low expectations.

Stock pickers deal with this all the time. At the start of the year, how often has your largest position (highest conviction = high expectations) performed the worst, and your smallest position (least conviction = lowest expectations) performed the best? Isn’t it crazy how often it occurs. 

In fact, you almost sold that small position after reading too many articles on sizing up and concentrated investing. Thank God you didn’t, because it was that small position that went up 500% out of nowhere that saved your year. 

We all have our favorite positions, and it’s usually the one that did the best last year. Ironically, the next winner is sometimes the one where most investors (and maybe even you) have the lowest expectations. 

In stock picking, you have two sets of expectations.  

1. Your expectations for a stock and business.
2. The market’s expectations i.e. what the majority in the stock expect.

It’s okay if you have high expectations for a business. The problem is when the market, the majority, has high expectations for a business.

Market expectations in microcaps can be gauged by a stock’s multiple (PE, EV/EBITDA, etc) and the amount of bullish chatter on forums, X, Substacks, fund letters, etc. 

High multiples + high bullish chatter in microcaps is where future returns go to die.  

When a stock moves higher, expectations move higher. When 100 investors are bullishly pounding the table on a microcap stock, the bullish echo chamber pushes expectations to levels business reality can’t meet. When everyone has high expectations, and the business doesn't meet them, stocks get crushed.

The other day a friend of mine asked me about a specific microcap company. I knew the company because it was widely discussed on MicroCapClub, X, everywhere. Everyone was bullish. 

I told him, “There might be some small Indigenous tribe in the Yukon that hasn’t heard of this company”. He laughed. I laughed. He understood what I meant. 

I’ve always been biased against companies that are already loved by the majority. I simply can’t muster the energy to dig into actively discussed and loved names, regardless of the story or fundamental merits. 

All winning stocks go from low expectations to high expectations. I want to buy into low expectations and start selling into high expectations. 

In your own portfolio be mindful of what other investors are saying and expecting. Their expectations dictate your future returns as much as yours. 

Stock Picker

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